Investing in stock markets is associated with great financial rewards. However, in order to become a successful investor and achieve the desired financial gains in the long-term, an investor must familiarize with the basics of investing in the stock market. One of the first steps as a novice investor is understanding the basic terms used in stock market investing and trading. In this article, we will introduce 10 of the most used to stock market terms. We assume that you are already aware of the fundamental terms such as buying a stock and selling a stock, so we will introduce other terms that are equally useful.
This is a term used by investors, analysts, and financial market commentators alike. A bull market is a stock market in which share prices are rapidly increasing. From a theoretical perspective, if a certain stock market rises by over 20% after a recent drop of more than 20%, it is deemed that this market has entered a bull market. However, there is no universal definition of a bull market. As investors, one should be aware that a bull market is when stock prices are rising across all or most sectors.
When a broad stock market index falls by more than 20% off a recent high, the market is said to have entered a bear market. Once again, there is no universal definition of a bear market, but it sure is something any investor would not want to experience in their investment careers. In a bear market, all stocks of companies despite their earnings or future growth potential tends to decline driven by an overall negative sentiment toward the performance of stock markets.
This is another term associated with a rapid decline of share prices. As opposed to a bear market, a pullback is when a broad stock market index falls between 10-20% from a recent high. Even though pullbacks create panic among investors, a pullback is often associated with a bull market. In a bull market, stocks tend to reach absurd valuation levels and these pullbacks help stocks trade at more reasonable valuation multiples.
This is a term associated with the level of price movement of a stock market. As opposed to identifying whether a stock is moving higher or lower, volatility measures the speed at which these price movements occur. In general, volatility is considered an investment risk by many investors and analysts. However, investment wizards including Warren Buffett believe that volatility indeed is a good thing for value investors who are on the lookout for great investment opportunities. The idea behind this is that volatile stock markets tend to irrationally bring down the market price of great companies, which creates an opportunity for value investors to invest in these companies at attractive prices. In the U.S., Vix Index provides a general idea about the expected volatility within the next 30 market days.
Liquidity is a measure of how easily and cost effectively an investor can buy or sell shares of a company. A large spread between the best bid and ask offers indicates that the liquidity of that particular stock is very low, which is an investment risk in its own right. For this type of liquidity risk, investors seek compensation in the form of higher required rate of return to invest in these types of stocks. U.S. and other developed markets are significantly liquid than stock markets in the developing world. The billions of dollars invested in these markets is the primary reason behind this higher level of liquidity. In general, companies with a very high market capitalization tend to have a higher level of liquidity in comparison to other companies with a very low level of market capitalization. However, this is not the sole determinant of liquidity of a stock.
IPO, or an Initial Public Offering, markets the issuance of a company’s shares to the general public. An IPO is the occasion in which shares of private companies trade on a stock exchange for the very first time. Investing in IPOs is a very popular strategy of many investors around the world, and some of the IPOs of private companies are highly anticipated. For example, many investors were eagerly waiting for the Uber IPO to invest in shares of the ride-hailing giant. An investor who is interested in buying shares in an IPO should deal with the brokerage house to wire the funds and get shares allotted.
Rights issue (secondary offering)
A company may decide to issue more shares to the public at a later date since its IPO, and this is referred to as a rights issue. A rights issue will first allow existing shareholders to purchase the additional shares that is to be issued by the company, but shareholders who do not wish to invest in the rights issue can sell his/her rights to a third-party shareholder as well. The rights issue price is usually lower than the prevailing market price at the time of issuance.
Dividends are a form of income distributed to shareholders by companies. In fact, dividends constitute one of the most important sources of income for investors. However, many investors take a long time to realize that dividends are an integral part of the total return of investing in stocks. Dividends are usually paid on a quarterly or annual basis. Dividends are paid in cash and provides current period income for investors. An investor can decide to get the dividend in to his bank account, or else to reinvest the proceeds of the dividend payment in the company distributing the dividend. This can be done through a dividend reinvestment plan, commonly referred to as DRIPs.
Margin trading allows an investor to invest with borrowed money from the broker or a third-party financial institute. In a margin trading account, an investor pledges his existing shares with the broker to use as collateral and in return, the broker borrows money to the investor based on the value of the existing portfolio. Margin trading can magnify both investment returns and losses of a portfolio. Therefore, margin trading is suitable for well experienced investors who are willing to take on additional risks to achieve better investment results.
Blue-chip companies are the leaders of the industries they represent. For example, Apple is a blue-chip company and is a leader of the global mobile device market. More often than not, blue-chip companies are expected to pay a stable stream of dividends to investors as well. One of the most common traits of blue-chip companies is that these companies are considered relatively safe investments considering the financial stability, historical performance, and capable management.
In this article, we looked at 10 stock trading terms every investor should know. There are many other terms an investor should master to become a better investor, and these terms are a good start for an investor.